CONTRACTS: A UNIFIED THEORY

The most efficient labor market mechanism depends on the advantages of specialization, workers ’ costs of switching between entrepreneurs, and the frequency with which needs change. Multilateral mechanisms are more efficient when specialization is more advantageous, when it is cheap for workers to switch between entrepreneurs, and when individual entrepreneurs cannot occupy a worker on a full-time basis. Given a bilateral mechanism, employment (a firm) is more efficient than contracts when in-process adjustments arise more frequently. There exists three regions in which firms, markets, and sequences of bilateral contracts are weakly more efficient than all other mechanisms in a big class. 3 Most economic research is conducted by taking a trading mechanism as given, imposing some subset of a standard set of assumptions, and then answering questions about the resulting behaviors and allocations. While this procedure has proven very fruitful, it raises some deeper questions: What determines the choice of mechanism in th